The T-Rex of mortgage REITs, Annaly Capital Management (NLY), currently has their 4 preferred shares within our hold range.
Annaly’s preferred shares carry our lowest risk rating of “1” on a scale of 1-5.
Source: The REIT Forum
We’ve found preferred shares provide an excellent opportunity for investors to get a high yield with lower volatility. We cover preferred shares frequently and today’s picks come our latest article for subscribers: Preferred Shares Week 141.
We believe preferred shares limit risk
We agree wholeheartedly with limiting risk. We prefer to overweight shares with lower risk ratings and we assign the risk ratings ourselves. There aren't many credit rating agencies covering these REITs, but we've covered the common shares and built up the knowledge necessary to evaluate the risk levels. We also benefit enormously from running a subscription research service covering preferred shares. One individual retiree would never have the time to do this manner of research for themselves. One more-than-full-time analyst plus an apprentice shouldn't have much difficulty doing it.
We cover about 50 or so preferred shares for subscribers on The REIT Forum, but rarely have positions in more than 15 at a time. We usually have our top choices heavily overweight as well.
Many of our subscribers are B&H investors. They use our research to screen for low-risk shares and then to watch for buy alerts so they can lock in higher yields. We believe that B&H investors getting higher yields without accepting higher risk leads to a much better portfolio performance.
REIT preferred shares can be an excellent part of a B&H strategy. If investors intend to hold for a period measured in years, then we think avoiding the expense ratio of the ETFs is a huge advantage. It allows the investor to either buy shares with lower yields (and higher credit quality, even if unrated), or to capture the higher yield for themselves. The normal expense ratios for preferred share ETFs are still painfully high because there hasn't been as much widespread competition as there has been for "whole market" ETFs or "S&P 500" ETFs.
Preferred shares offer investors a higher yield than the common stock will normally carry. Further, preferred shares generally carry less volatility and less risk. Preferred shareowners usually do not have voting rights. However, preferred stock does have a higher priority on assets and earnings relative to common stock. Keep in mind that the preferred share dividend cannot be cut unless the common stock dividend is cut to zero. If that were to happen, for the common stock to start paying a dividend again the preferred shareholders are paid all unpaid dividends if the preferred shares are “cumulative”.
We only cover cumulative preferred shares.
Aggressive investors or traders may be opposed to preferred shares because of their defensive nature. However, we believe there are opportunities for aggressive investors in the preferred share space. Higher yield preferred shares may be a great fit for an investor who is willing to take on more risk. Further, for investors who are willing to trade, we’ve had excellent success when trading in and out of preferred shares.
That includes dividend captures.
Dividend captures may be scary for some investors.
However, done correctly dividend captures do not need to scare investors. Dividend captures are inherently a play on inefficient markets. Theoretically, the success rate should be low. In practice, our success rate has been extremely high.
Our strategy for dividend capture is to have less risk and volatility. How? we find price targets where the security is at a good bargain. If the dividend capture doesn't work right away, we’re okay with holding shares and collecting the dividends.
If you want to know more about how dividend captures work, see our guide for preferred share dividend captures.
NLY preferred share dividend capture
Since we’re bringing up the topic of dividend captures, we’ll take a look at how an investor would’ve performed with any of the NLY preferred shares over the last month. We owned shares of NLY-C (NLY.PC) and opted to hold onto them through the ex-dividend date because of the potential for a great dividend capture opportunity.
Source: The REIT Forum, chart from 3/3/2019
The preferred shares delivered returns between .78% and 2.41% over the prior two weeks (through 3/3/2019). NLY-G (NLY.PG) performed remarkably and shouldn’t be seen as typical. It is extremely rare for the performance to be near that strong. However, excluding NLY-G, the returns ranged .78% to .98%.
The annualized rate of return runs from 22.83% to 29.00%.
This is why we like to mix in dividend captures as a way to enhance our total returns. The dividend captures don’t always work, but we’ve had success identifying them often enough. We’ve rarely had negative total returns, though that risk always exists. Investors going into a dividend capture need to remember that they are not required to sell the shares immediately after they go ex-dividend. If the price is weak, we simply sit on the shares and wait.
With the recent rally in NLY-C (NLY.PC), we monitored the open market prices for an opportunity to close out our position and reallocate. We purchased the shares at $25.15 on 1/24/2019, so we’re up 2.4% for total returns including the dividend in about 40 days (as of 3/3/2019). We published a buy alert at the time:
Source: Seeking Alpha
Here is a chart of NLY-C showing our buy and sell dates. We had a return of 2.65% over a period of 40 days:
We closed our position in NLY-C at $25.33 on 3/5/2019.
We collected $0.48 in dividends.
The purchase price was $25.15.
If you have a question about preferred shares, please leave a comment. The intent of this article was to give investors an example of how to use relatively safe preferred shares as a trading investment. Annaly Capital preferred shares are some of the best in the sector for buy-and-hold investors. However, that doesn’t mean that aggressive investors can’t make a good return from trading off our analysis. Currently, NLY’s preferred shares are a hold (neutral rating) and we will continue to keep an eye on them. NLY-C played out nicely as a dividend capture.
100% of our revenue from this article in the first month will be donated to a charity. In March, we will be supporting All Breed Rescue And Training.
The REIT Forum is the #1 rated service on Seeking Alpha. We focus primarily on defensive investments with high growth potential. It is our objective to find quality investments at a discount, along with trading opportunities for the more active investors. Most of our research is on companies that are excellent investments over the long term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.